Sunday, September 29, 2013

How the Economic Machine works by Ray Dalio

Twists and Turns via Hyperbolic/Exponential Discounting

The law of diminishing returns can be summarized easily: too much of a good thing can make you sick; in some cases more sick than in others. Increases in total outcomes are not necessarily linked to increases in individual factors of production

There is so much pizza you can eat before it makes you sick and there are so many Master Degrees (if any) a person can obtain before student loans and other costs outweigh the benefits (increased salaries and such). 

To ground the idea with a more Economics-based example: there is a limited number of livestock, seed and workers that can be slaughtered, planted and employed in a farm, field and factory before output starts tapering off and marginal output starts contracting.

The quest for returns has made firms recognize this law and auto-correct if they dare break it.

But when considering a different set of laws, ones regarding investments - firms, individuals and governments rarely behave optimally...or rationally.

Theory states that agents/players utilize exponential discounting to determine their utilities. This method provides a clean-cut, time-consistent process that determines an investment's utility over time. Hyperbolic discounting, however, discounts short term gains at a higher rate than long term ones. Some empirical studies argue that people do in fact discount the short term more heavily than years ahead, proving that in practice, preferences change over time. 

The interesting problem comes when players under-discount future risks and losses and therefore make investments in the present that may not be the most favorable for them in the future. Social implications therefore abound: arbitrarily choosing to binge on vanilla ice cream today can manifest health risk factors in the future. Smokers regularly discount future risks hyperbolically; Bertrand Russell, a long time smoker and occasional philosopher (small joke), lucked out and died at 97, but most would agree that smoking is a slow countdown to death. And as such, should be heavily discounted.

Money today, it has been said, is worth more than money tomorrow. But money in 10 years, most believe, is worth practically the same as a bit of more money on the 11th year. As one approaches the 10th year though, money on the 10th year is once again valued above money on the 11th. And this is how preferences have been shown to change, resulting in agent's behavior aligning more with hyperbolic discounting than exponential discounting.

After having watched two post-apocalyptic films this weekend (Oblivion and Elysium), where the short-term actions of a whole civilization resulted in long-term damage, I realized the importance of discounting wisely:

In Politics: 
Short term gains as delivered by politician's campaign promises to constituents can and will backfire. Politicians are known to take the public's crap, and still ask for more, so much so, that in the end, all they do is try and please. Who is watching out for whom is anyone's guess. In the end, the people get the government they deserve; which shows how the public's predilection for instant gratification and mass hysteria when promises aren't kept constantly get in the way of investing in the future.

In Economics, Social Development and Order:
Developed economies are growing their GDP at 1% to 2% a year. Accumulating debt at an exponential rate is only viable if growth is increasing at the same rate. Cheap resources are becoming scarce and the economy cannot grow fast enough to make up for that fact. The search for yield has led to cheap money to land elsewhere (emerging markets, or local high risk investments). Social implications take the form of lost opportunities, greater income disparity between social classes and serious overall soul-searching.

In Education:
Rising education costs. Re-framing the MBA: are Finance jobs done, and are Entrepreneurial careers in? I'm all for it: I would rather create value through new companies than engage in astute money plays.

And then?

Example: A couple of years ago I was thinking of which MBA to go to, and I asked Seth Godin for his opinion. Seth is a generous person and is great at answering emails. His answer was (paraphrased): Why don't you take that money and start a company instead?

I thought about that long and hard, but decided not to. In my case, I applied Hyperbolic Discounting in my decision. I under-discounted the future risk in having to pay for graduate school in return for two years of unparalleled education. 

And it paid off. My current situation is a product of what I learned and did during those formative years. Drop-outs, Non-MBA's and successful prodigies can disagree, but in the end, it all depends.

What's perplexing is that Hyperbolic Discounting benefited me, when it probably, through particular circumstances, could have very well harmed someone else. 

What is clear though, is that, while there is no proverbial crystal ball, and predicting investment risk through well thought out discount rates is somewhat non-scientific, the theory behind discount rates is sound enough to help in making informed and conscious decisions regarding what could or might be.

The decisions agents "can live with" are suboptimal and myopic - aspiring to make the right decisions in spite of what an investor can live with could and can make a difference.

Sunday, September 22, 2013

Who do you obey?

You can even do it in the board room.

Took a dive into the spiritual realm recently and decided to check out the Upanishads.

According to Wikipedia:
The Upanishads are considered by orthodox Hindus to contain revealed truths (Sruti) concerning the nature of ultimate reality (brahman) and describing the character and form of human salvation (moksha).
This is a rich way of explaining the alll-encompassing nature of the texts.

A gem I found in the collection (specifically in part III - Katha):
The sense of the wise man obey his mind, his mind obeys his intellect, his intellect obeys his ego, and his ego obeys the Self.
The words convey a subtle yet direct message; the wise, as is denoted in the sentence, follow a chain of command that carries out orders from the top, the "top" here being the "Self" (i.e., the spirit/soul/essence).

Reality check: How many egos obey the Self? 

Every day impulses and vices (just consider the 7 deadly sins) are driven by the mind (impulsive instant gratification rewards await), and the rest by the intellect/ego.

The intellect, inasmuch as it refers to the capacity human beings have to resolve problems and subsequently determine a rational course of action to do so, is enough, in most circumstances, to live by. In other words, leaving the soul out of one's life, can work for a while, but in theory, not in the long term.

Note: I'll leave the definition of "Self" (i.e. the soul) to the reader. 

The problem here is: how can one achieve a true connection with the Soul without being a monk or a cloistered nun?

How does a business world inhabitant -  an Investment Banker, an Engineer, a Salesman or a CEO - to name a few, balance it all out? In these individuals, does the Intellect/Ego divorce itself from the Self, and are both therefore attended separately? 

The separation itself leads to falling back in line with the Intellect/Ego. There might not be a true possibility for a verifiable separation.

Referring to a religious man - 

Pope Francis, when asked in a recent interview who he was - responded: 
“I ​​do not know what might be the most fitting description.... I am a sinner. This is the most accurate definition. It is not a figure of speech, a literary genre. I am a sinner. 
When I first read this I thought about the Catholic Church; whose members are taught that they are sinners by default. 

After reading the text from the Upanishads I referred to previously, I realized how profound Pope Francis' self-description was:

We are all, in some way "sinners". Even monks and swamis have bad days, in which they undoubtedly make mistakes. When they are in touch with their Self they might make less, but being in a perfect state of existence is an impossibility, at least when regarding life in practical terms.

Yet the mere reflection regarding whether we're guided by our Self merits further discussion. Contemplating a deeper connection to one's innate sense of purpose is something that is not only reserved for the spiritual or religious. And separating the Self from the Intellect/Ego can, therefore, be avoided.

Granted, juxtaposing the proverbial monk with the secular white collar capitalist to compare their practices and as such, their relation with the Self, seems silly, if not insane, but considering what they have in common, at least when considering that both are subject to the human condition, can lead to interesting questions. 

And an interesting one is: Who do you obey?

Tuesday, September 17, 2013

Sunday, September 8, 2013

Intuition vs Intellect - Being clear is being right

Put that in your pipe and smoke it. 
Bertrand Russell is the ultimate badass.

Why? Because he's superiorly witty and he makes sense of things in a rational way.

He also put his money where his mouth is.

He was thrown in prison for his activism, and he stood up against church and state throughout his lengthy career. He was also a gifted writer, which make his books great reads.

Here are some excerpts from Russell's "Our Knowledge of the External World"

On Intuition vs Intellect:
"It is neither intellect nor intuition, but sensation, that supplies new data, but when the data are new in any remarkable manner, intellect is much more capable of dealing with them than intuition would be. The hen with a brood of ducklings no doubt has intuitions which seem to place her inside them, and not merely to know them analytically; but when the ducklings take to the water, the whole apparent intuition is seen to be illusory, and the hen is left helpless on the shore. Intuition, in fact, is an aspect and development of instinct, and, like all instinct, is admirable in those customary surroundings which have moulded the habits of the animal in question, but totally incompetent as soon as the surroundings are changed in a way which demands some non-habitual mode of action." 
"Intellect, in civilized man, like artistic capacity, has occasionally been developed beyond the point where it is useful to the individual; intuition, on the other hand, seems on the whole to diminish as civilization increases. Speaking broadly, it is greater in children than in adults, in the uneducated that in the educated. Probably in dogs it exceeds anything to be found in human beings. But those who find in these facts a recommendation of intuition ought to return to running wild in the woods, dyeing themselves with woad and living on hips and haws."
Why this is relevant:

Social and educational promotion of the intellect, and its application in problem-solving, critical thinking and logical reasoning leads to enlightenment-type ideas to arouse in people, leading to beliefs that establish that advances in the arts and sciences produce a better state of being for human beings (as promoted by theories like the Idea of Progress). In this regard, intellectual stimulation is good.

However, deviating from the rational application of the intellect, that is, falling prey to irrational thought or unclear thinking, even in the pursuit of developing the human condition through seemingly logical thinking, leads to unsatisfactory outcomes; manifesting in macro-settings as economic/social strife, decadent societies and scientific incompatibility with human advancement.

Practical Applications:

Individual intellectual advancement, in today's modern 21st century highly competitive environment, where the "Knowledge Worker" reigns, can lead to better decision making. Ethical implications become relevant as societies transcend and basic needs have been met. Relying on intuition is frankly, not enough.

On Rationalism and Science vs Intuition in understanding Reality:
"The philosophy, therefore, which is to be genuinely inspired by the scientific spirit, must deal with somewhat dry and abstract matters, and must not hope to find an answer to the practical problems of life. To those who wish to understand much of what has in the past been most difficult and obscure in the constitution of the universe, it has great rewards to offer - triumphs as noteworthy as those of Newton and Darwin, and as important, in the long run, for the moulding of our mental habits. And it brings with it - as a new and powerful method of investigation always does - a sense of power and a hope of progress more reliable and better grounded than any that rests on hasty and fallacious generalization as to the nature of the universe at large. Many hopes which inspired philosophers in the past it cannot claim to fulfill; but other hopes, more purely intellectual, it can satisfy more fully than former ages could have deemed possible for human minds."
There is something to be learned from a man that was so vehement about modernizing (at the time) philosophy through formal logic and analytic scrutiny.

Insofar as the improvement of the human condition is concerned, we should all, as the human race, be for it.

And clear thinking might be the first step:

Practical and Useful advice on Presentations

Fail proof.

Sunday, September 1, 2013

Giving control to the customer - Netflix has done it well

A friend of mine sent me a video that's gone viral:

Kevin Spacey urging TV Channel executives to give control to viewers

It's going to be interesting to see how Netflix's business model and other tech-based disruptive innovations will affect what consumers demand and Netflix's competitors roll out in the coming year.

Kudos to Netflix for rolling with the punches after it's stock took a hit in 2011 when it decided to raise its subscription prices.

The market had lost faith back then (as markets often do), forcing the company to subsequently go through a sustained market price trough, taking shareholders along a rough ride (having experienced a high of $300 per share to then see it plummet to the low $50's), until early 2013, when it began to bounce back.

Keep that slope positive please

Having the market punish your company and then staging a comeback that doesn't come down to just pricing strategies, is very respectable.

Let's hope they keep innovating.